Real Estate Note Investing: A Complete Guide

Real estate has dozens and dozens of ways to make money and wealth.

You’ve probably stumbled across the typical “rental” and “flip” models.

But there’s another way to make real estate bring you money…

And that’s by being the bank!

Let’s get into some basics before we get into the nitty gritty…

What is a real estate note?

When a buyer finances the purchase of real estate through a mortgage, a promissory note is created, which is a “promise” of paying back the loan with specific terms.

When you take out a mortgage to buy a property, for example, you sign a note that specifies the amount of the loan, the interest rate, the repayment schedule, and any other important details.

Here’s a list of other terms that are interchangeable with “real estate note” in the US:

• Promissory note
• Mortgage note
• Borrowers note
• Real estate lien note

How can you “invest” in real estate notes?

There are two (basic) ways for you to invest in promissory notes.

1. Anyone can buy a real estate note from the originator — We’ll cover this later but you can buy notes from banks or others how have created them; therefore YOU would be getting the payments thereafter buying it
2. Originating a note — for example if you own a piece of property free and clear (it doesn’t have to be free and clear but we’ll cover this later), and you sell it to someone on payments.

So in either case, you’re putting some sort of investment up front (it could be your time or money to purchase the property or the note), and then collecting payments on it.

How do you make money with real estate notes?

Three ways:

1. Collecting payments (cash flow)
2. Taking back the defaulted property and then either flipping it, renting it, or reselling it on payments again.
3. Selling the note — you can “flip notes” by buying them (or creating them) at a discount and then selling them to other investors

 

Pros and cons of real estate note investing

As with any strategy to make money, there are ALWAYS pros and cons…

So here are some things to keep aware of…

Cons

1. You don’t own the real estate — When you own a promissory note, and someone owes you, you are not the owner of the property (this can also be a good thing that we’ll cover later), you are only the “lien holder”, just like a bank.
2. You don’t (typically) gain any equity — if you’re the lien holder, you typically don’t gain any appreciation on the equity… you only collect what’s due to you (although we’ll cover later how this isn’t always the case).
3. There’s risk — There’s risk in everything, and with note investing, you can have a borrower stops making payments to you, so you’ll have to be prepared if that happens (foreclosure, taking over the property, etc).
4. The cash flow has an end — if the borrower finishes their payments to you, you’re cash flow dries up.

Pros

1. You don’t have to maintain the property –– Unlike rentals where the landlord (property owner) is typically responsible for any repairs… maintenance, repairs, etc are not the responsibility of the lien holder. So you’re collecting payments without ever having to worry about paying out repairs (unless you take back the property).
2. Big ROI — depending on your strategy (we’ll go over strategies later), you can gain big double-digit returns.
3. Easy cash flow –– Once you create your note of buy, typically the cash flow starts right away when they start making payments; there’s no finding a tenant, and there’s no “negative cash flow”.
4. You can “recycle” the property — Getting a property back might sound like a negative but it can actually be a positive for some people. Because the downside of note investing is that your cash flow could end when a borrower finished their terms with you… UNLESS they default and you have to take back the property. Then you can resell the property on another note (or flip it, or rent it).

Strategies for real estate note investing

As with any real estate strategy we strongly advise you to consult a lawyer for proper paperwork and a financial advisor for strategies…

So let’s get on with some strategies that investors use in note investing:

1. Buying defaulting notes — Across the US there are people who aren’t making payments on their mortgages. Whether the lien holder (the person who is owed) is an institutional bank or a regular person down the street who’s sold a property for payments… you can purchase the note from them. And the benefit to that person is they get their money back and clear that note out from their books and NOT have to deal with foreclosing. If you’re patient, you can talk with the property owners to try and get them paying again, or take back the property according to your state’s foreclosure laws (and then you gain a property). This presents an opportunity for savvy investors to acquire a property or loan at a reduced cost. When buying promissory notes from banks, it’s important for buyers to do their due diligence in order to make sure they are making sound investments. Investors should research the market and understand current interest rates in order to determine whether buying a note will be more financially beneficial than other investments. Additionally, buyers need to assess the borrower’s creditworthiness and collect data on delinquency habits before committing to a purchase (again, discuss this strategy with a real estate lawyer before you commit)… Here’s a video that shows you how to buy notes from the bank:
2. Land Flipping — This falls into the “note origination” strategy. While with the above strategy, you buy an existing note from someone else… here you first buy the property, THEN sell it on a note. Typically in this model, you’re buying raw vacant land that is cheap; for example, buying a property for $5,000 and then re-selling it for $10,000 on payments. Check out this video on the basics of land flipping:
3. Tax lien certificates — This is not directly a “note investing” strategy, but technically you do become a lien holder and then are owed a certain amount.
   In some states, when a property owner is late on their tax payments, investors have the opportunity to buy what’s called a “tax lien certificate”, which means that you are paying the late taxes on behalf of the owner, and then that property owner owes you your investment plus interest. If they never pay you back, you can foreclose on the property. Here’s a video on investing in tax certificates:
4. Mobile home flipping — Similar to land flipping, you buy a mobile home and then resell it on payments… It doesn’t need to be a mobile home on land (meaning you own the land underneath) it can ALSO be mobile homes in a park where you pay a rent space. This might sound like a negative but it’s doesn’t have to be. Because at the end of the day, cash flow is what matters. And mobile homes (even in a park), if you buy it low enough, and resell it high enough with good terms, you can gain some great cash flow and some amazing ROI percentages.
   This strategy is called “Lonnie Deals” named after Lonnie Scruggs who made this strategy popular strategy in the 70s/80s.
   Here’s a video explaining this strategy:
5. SFRs — just like with land and mobile homes, this can be done with single-family houses as well (really with ANY property).

Buying property on a note — Seller finance

We’ve talked about selling property on notes…

What about buying it on notes; aka “Seller Finance”.

This is a creative finance model that is a great way to purchase property without a lot of money and without banks — essentially getting the owner of the property to finance the property for you; they become the note holder.

Wrap Mortgages

We’re getting more advanced with our strategies and this is a combination of buying a property with seller finance and then selling the same property on a note and you being in the middle, collecting cash flow.
This takes having the right paperwork and making sure you dot all your “I’s” which goes beyond this article — consult with a real estate lawyer before attempting.

But know that this strategy can be VERU lucrative. Essentially, you find a free and clear property to buy at a discount, then you enter into an agreement to buy the property from the owner with a promissory note to that owner, then you re-sell the property on a promissory note with higher payments than the 1st promissory note, you collect the difference.

For example… 

1. Buy a property for $100,000 (it’s worth $120,000)
2. Pay the owner $5,000 down, and $100 a month
3. Re-sell the property for $120,000
4. Finance the property to the new owner
5. New owner pays a down payment (to you) of $5,000, and $150 a month
6. You collect the difference: $50
7. You do no maintenance or repairs.

Here’s a video explaining it:

How to sell notes

Whether you create a note or buy it… you can sell it for a profit.

Why would you do this if it’s cash flowing? 

1. This is your business model (buy/create notes at a discount, get payments current, then resell for a profit)
2. You need cash (when something happens you need money quickly, you can sell your note (or parts of it) to another investor. They will most likely ask for a discount)
3. Repositioning (This note might not be a great return and you can reposition your investment into a better investment)

Who do you sell a note to? 

1. To your friends or inner circle of investors
2. On a secondary market (like a network where you list notes)

Summary

Real estate note investing is a lucrative and potentially profitable option for anyone looking to diversify their portfolio.

It has both pros and cons that must be considered before jumping into the market, but with strategy and thoughtful research, investors can achieve success and reap returns on their investment.

There are various strategies to explore when it comes to real estate note investing—buying defaulted notes, creating notes through buying properties and reselling them on payments, using wrap mortgages, or simply buying notes on the secondary market. No matter which one of these approaches you take, remember that you can always sell your notes for a profit or if you need quick cash as long as you buy it right!

So if you’re considering real estate note investing, do your due diligence and get ready to reap the rewards (and consult a lawyer for the proper paperwork)!

Don’t forget – be sure to share this article with friends and family so they too can understand what real estate note investing is all about!